Comptroller Speaks to the American Bankers Association about Credit Risk and Loan Loss Reserves

PHOENIX, AZ - Comptroller of the Currency John C. Dugan cautioned bankers against easing underwriting practices and inappropriately lowering loan loss reserves during today’s speech to the American Bankers Association.

Mr. Dugan shared results of the interagency Shared National Credit review and the OCC’s 2006 Underwriting Survey. While generally positive, this year’s SNC review showed a small decline in credit quality that followed a long period of improvement.

"Even such a small decline in credit quality, however, is still a decline," Mr. Dugan said. "We will be monitoring whether this year’s decline portends a change in direction, or simply a stabilizing of credit quality of the syndicated loan market."

The Comptroller’s concerns about credit risk stem from the OCC’s 2006 Underwriting Survey, now in its 12th year. The survey examines 18 different product lines in the 73 largest national banks and is based on the professional opinions of OCC’s on-site examiners.

"What the Underwriting Survey says this year should give us pause," Mr. Dugan said. "Loan standards have now eased for three consecutive years." The Comptroller reported "slippage" in commercial lending involving leverage lending and large corporate loans as well as in retail lending with significant easing in residential mortgage lending standards including home equity loans.

"We don’t want to see lending decisions bankers make today result in excessive foreclosures – and reduced affordable credit – tomorrow," he said.

In light of increasing credit risk, Mr. Dugan emphasized the importance of maintaining today’s strong loan loss reserves. "Solid loan loss reserves – representing the best estimate management can make of how much money the bank will lose on the loans it has made – are critical to a bank’s safety and soundness," said the Comptroller. "That is especially true today, at a time of rising credit risk, easing underwriting standards, concentrations in some loan products, and a lack of performance experience with others."

"In presenting results such as these, we are always mindful of the need to avoid painting a darker picture than is warranted," Mr. Dugan added. "The challenge we face is managing this risk in an effective and timely way and doing it now – while credit quality is still good, while loan loss reserves are strong, and while the economy is robust."

In addition to credit risk and loan loss reserves, the Comptroller also stressed the important role of community bankers within the national bank system today and OCC’s focus on providing value through its supervision process. Community banks make up 92 percent of the banks that OCC supervises, involving 65 percent of the agency’s bank examination force.

Community banks "face an increasingly complex set of compliance requirements covering anti-money laundering, fair lending, and consumer disclosures," Mr. Dugan said. He added that "community banks sometimes need more guidance to comply with the regulatory maze" and "OCC examiners are trained and encouraged to provide advice that goes beyond the scope of the formal examination for those banks who want it."